Instability, thy name is FSDC

Here’s a hypothetical scenario. The rate of capital flows and rupee appreciation is breaking records. So policymakers start deliberating. First, a sub-committee organizes a meet in New Delhi: The finance secretary is inclined against action, but the central bank governor—chairing the sub-committee—pulls consensus the other way. Then, regulators convene a second meeting with a fuller council, chaired by the finance minister who, after more deliberation, reverses the sub-committee’s decision. All the while, the capital deluge and currency rise continue. And India does nothing.

In some weeks’ time, this scenario may not be imaginary. It was announced on Tuesday that the new regulatory body on the block, the Financial Stability and Development Council (FSDC), would soon be formed, now that reservations on its creation have been set aside.

And there have been ample reservations. As Mint reported in July, Reserve Bank of India (RBI) governor D. Subbarao had written to the finance ministry, worried that FSDC could erode RBI autonomy. The optimist would note that, in the face of these reservations, the finance ministry has been willing to compromise. According to the old consultation paper, FSDC was to have two sub-committees: Now it will have only one, with the RBI governor at the helm.

When it comes to politicians trying to have their way, though, we aren’t as optimistic. These changes are cosmetic, made to assuage a worried RBI governor and ensure that he stays on board this new project. Considering the buck still stops with the finance minister, India’s political class clearly believes financial stability is its province. We think otherwise.

A good amount of post-crisis research, especially from the Switzerland-based Bank for International Settlements, points to the vantage position a central bank enjoys here. It prints money and acts as lender of last resort. If the political class had its way, RBI would be lender of first resort to the government.

What’s more, the not-so-hypothetical scenario above shows that one big source of instability for India is—and will remain—the nature of capital flows. The finance ministry’s recent comments show that it has no problem with a capital flood. But RBI does. It’s the body that looks at, and can quickly intervene in, say, currency markets. If it’s now reduced to one cog in the giant bureaucratic wheel of FSDC, this scenario looks scary.